Fintech in a changing world

Good morning! I want to begin by extending a warm welcome to everyone here in Philadelphia and to those of you joining us virtually. One of the benefits of hosting a hybrid conference like this is that we get the benefits of being together physically—I’ve had some of my best ideas on the sidelines of conferences like these—while also being able to welcome a lot of people who couldn’t make it to Philadelphia .

It is great that we have such a large turnout today. I think that’s a testament not only to the growing interest in the topic we’re here to discuss—fintech—but also the amazing lineup we’ve assembled for this, the Philadelphia Fed’s sixth annual Fintech Conference. My colleague Julapa Jagtiani, the organizer of these proceedings, has indeed done it again. If you’ve never been to one of our fintech conferences before, trust me, you’re in for a treat. Over the next two days, we will hear from the leading voices in industry, government and the Fed.

And speaking of the Fed, here’s where I give my standard Fed disclaimer: The views I express today are my own and do not necessarily reflect those of anyone else on the Federal Open Market Committee (FOMC) or in the Federal Reserve System.

Our last fintech conference was in November 2021, and although it wasn’t even a year ago, I think it’s safe to say that conditions for the fintech industry – not to mention the wider economy – have changed dramatically.

I will give one example. Last November I talked about the rapid growth of buy now, pay later firms, effectively repurposing Kmart’s old layaway model for the digital age. With buy now, pay later, buyers can split payments for purchases into a series of installments – sometimes with zero interest. And unlike with layaway, consumers benefit from getting the product up front and paying for it over time. This has proven to be a popular option, with buy now pay later representing $2 out of every $100 spent on e-commerce in 2021.

Buy now pay later looked robust in a low interest rate environment. This is because the vast majority of companies in the area do not have any deposits to draw on. Instead, they borrow money which they then turn around and lend. Typically, their income comes from fees charged to sellers.

Rising prices have drastically changed the landscape for buy now, pay later. These companies are forced to borrow at higher interest rates, and are facing a pressure they simply did not have in November last year. Unsurprisingly, major operators in the area have pulled back, with one of the leading lenders shedding 10 per cent of its workforce last month.

The fintech landscape is changing rapidly as a result of macroeconomic conditions. There are significant developments happening and we are lucky to have so many wonderful panelists here this week to discuss them.

The use of buy now, pay later has important implications for providing financial services to low- and moderate-income consumers or others who may be excluded from more traditional means of obtaining credit. Consider a young adult in their first job who has no established credit history and therefore cannot be approved for a bank credit card. She can now use buy now, pay later to finance that important purchase. Also, some buy now pay later lenders report payment history to credit bureaus so these new borrowers can start building a credit history.

Or consider the family that declared bankruptcy several years ago and continues to be charged high rates on traditional forms of lending, even though they are back on their financial footing. Buy now, pay later offers an alternative method of accessing credit.

A Philadelphia Fed survey of buy-now-pay-later users in the United States found that users are generally non-white, earn less and are younger than users of other payment methods such as debit and credit cards.

In other words, fintech can help promote financial inclusion. It is undeniable. But then far from inevitable.

Like all tools, fintech can be used for good, bad or somewhere in between. Just as fintech can promote frictionless legitimate transactions, for example, it can promote frictionless ones fraudulent transactions as well. Fraud is an example of how a little friction can be a good thing.

Fintech has evolved a lot in the six years we’ve hosted these conferences, and the discussions we’ll be having over the next two days have moved out of the largely theoretical and always into the realm of the empirical. We have increasingly rich data sets here in the US and abroad that provide important insight into how fintech is reshaping the credit markets.

Take one example: A recent paper examined how fintech lending differed from traditional bank lending in China during the onset of the COVID-19 crisis. Analyzing the spread of unsecured personal loans from three major fintech firms and one major commercial bank, the researchers found that fintechs were more likely than banks to extend credit to new and financially constrained borrowers. Fintech borrowers were more likely to be unemployed, to earn lower incomes and to have had past delinquencies.

A happy story, right? Well, not quite.

That’s because it turns out that the default rate for fintech loans tripled after the COVID-19 outbreak, while there was no significant change in the default rate for bank loans over the same period. This is a puzzling finding, somehow suggesting that, at least in this case, fintech lenders were unable to accurately predict borrowers’ financial health in the event of a pandemic, but commercial banks were. It strongly suggests that the Chinese fintech firms were operating with imperfect or insufficient information about their borrowers. Although extending credit to the financially constrained can potentially be beneficial, it does not help lenders or borrowers if the loans end up being overdue.

But this is hardly an iron law: Other examples have found that fintech loans fall due at a lower interest rate than bank loans. It suggests that elevated or lower credit risk is not necessarily inherent to fintech itself, but rather depends on each firm’s particular business model.

Another recent paper examining unsecured small business loans in India offers an important example. There, the authors found that when fintechs used a more holistic method to evaluate borrowers’ credit risk than a simple credit score, both borrowers and lenders benefited.

Over several years, small businesses in India seeking credit from fintechs agreed to share data on their so-called cashless payments, certified checks, online banking, mobile banking, point-of-sale transactions and money transfers on mobile apps. The result? They gained access to larger loans at lower interest rates than those who used traditional credit scores to obtain credit.

One can imagine such a model working here in the USA, where people with limited credit can demonstrate their creditworthiness in other ways than their credit scores. In my opinion, there is no good reason why timely rent and utility payments should not be as crucial to getting credit as timely payments for car loans or credit cards.

Again, the possibilities of using fintech to reach the financially constrained and financially marginalized are really exciting – and very important. It is now up to all of us to seize them.

So again, thank you so much for joining us. We have a very rich menu of programming over the next two days, which I’m sure we will all benefit from.

I will now turn things over to David Mills, my colleague from the Board, who will lead a discussion on the future of payments.